“Cash is king” is such a stupid expression. I usually hear it in the context of fat cat Wall Street analysts discussing the assets of multi-billion dollar corporations, and I’m so used to tuning those voices out.
Which might be why I found myself in the following situation an embarrassing number of times this year: closing comfortable five-figure deals with a client in the afternoon and then walking 5km at night because I couldn’t afford the bus fare to meet up with my friends. Or raiding my pantry for a week while waiting for a cheque to clear, because I couldn’t afford groceries.
While those moments have a learning value all their own (a momentary glimpse beyond the privilege any average middle-class North American kid is born into by default) the fact that I let myself get there is not at all something to be proud of. Those stories of tech wunderkinds living off ramen noodles while huddled together inside a tiny apartment trying to be the next Facebook are not something to aspire to. I don’t buy for a second that entrepreneurs need to starve before they can “make it”, but many of them have stories similar to mine because cash flow really is complicated. Here’s why:
In the software industry, as well as many others, work is performed on credit, ie. my company builds something because another company agrees to pay us for it, but (generally speaking) we don’t finish getting paid until the job is done. Even then, industry standard payment terms generally allow for 30 days from the date of the invoice (“net 30”). So far, all of this is obvious and where I would normally start tuning out, but if you’re [thinking of] starting a small business that isn’t entirely cash-based and you don’t have at least three months of burn in the bank you should keep reading.
To help illustrate the situation I’ll use the following hypothetical scenario (feel free to substitute whatever numbers make sense in your location and industry):
Some developers take on a one month project, billing $15,000 for the work (which is the amount they cumulatively expect to make in a month). The client pays $7,500 up front; a 50% deposit.
Now, assuming the project finishes on time and on budget, and is fully paid within the 30 day period following project completion (a very brave assumption!) and assuming that those developers have a strong sales pipeline bringing another $15,000 project with a $7,500 down payment right away the following month (another brave assumption!), there is no problem. But what if the next month sees smaller, one week projects of $4,000 a piece? The down payment for that would only be $2,000, meaning that the developers only see $9,500 instead of $15,000 in the first month. If there are a few days of lag between the first month’s project and collecting the first down payment in the second month, it gets even worse. And if the developers in question are employees expecting a regular payroll… the math just doesn’t work. There’s still money coming in, and work going out! The company is doing just fine! But it isn’t, because if there’s no money in the bank the company is dead.
If you include bad debt (clients who don’t/can’t pay) in the above scenario, or clients who just pay late, or projects that go overtime (adding extra time to the tail end of a project will happen sometimes, but it typically means that the invoice will be issued later and therefore so will the payment), or projects that are just a bit bigger than the company is set up to handle (a three month project with 50% up-front and 50% on completion is not uncommon, but a small business that didn’t plan carefully might not be able to make it through the third and fourth months before collecting payment) it becomes pretty clear how cash flow can present serious problems to the smallest, simplest business endeavours. That is what “cash is king” really means, and what I wish I’d cared to find out years ago. But sometimes learning the hard way is the best way; cash flow planning is burned into my brain now, and I think I’m getting better at managing it.